Silver lining: CAD likely to be within RBI's comfort zone after 3 years

Rupee recovers on rate hike

For the first time in three years, the current account deficit is expected to fall below the Reserve Bank of India's (RBI) comfort zone, as the central bank now predicts the deficit to narrow to 2.5% of GDP for 2013-14.

The CAD was record high last fiscal when it touched 4.8%.

Current account deficit below 3% is seen as the comfort zone of RBI.

The current account deficit fell to 1.2% in the second quarter following various import restrictions, particularly on non-essential items like gold.

“Another silver lining is the significant narrowing of the trade deficit on the back of resilient export growth... The recent resumption of capital inflows should help finance the current account deficit comfortably,” RBI governor Raghuram Rajan said in the third quarter monetary policy review.

The improvement in the external sector has helped the rupee rebound from the historic lows that it touched in end August. The government estimated the deficit to narrow to $50 billion for the current financial year.

“Reserves have been rebuilt since September, and are expected to increase further as oil marketing companies, that have been buying foreign exchange in the market, repay the Reserve Bank when their swaps come due,” Rajan added.

The rupee, which fell for the last three trading sessions, appreciated after RBI announced hike in the repo rate. The rupee was trading 62.93 per dollar as compared to the previous close of 63.10/dollar.

While hiking repo rate by 25 bps to tackle inflation, Rajan said high retail inflation is also a risk for the currency’s stability.

“The gravest risk to the value of the rupee is from CPI inflation which remains elevated at close to double digits, despite the anticipated disinflation in vegetable and fruit prices,” RBI said.